Greenspan: Recession biggest worry

WASHINGTON (CBS.MW) -- Exuberance returned to Wall Street on Tuesday, and it was entirely rational.

Alan Greenspan, the Federal Reserve chairman who's been the chief thorn in the side of the stock market, finally said what just about everyone on Wall Street's been saying for months: The risks to the U.S. economy have shifted from too much inflation to too little growth. Read his speech.

Eighteen months after the Fed first began raising its overnight interest-rate target to bring supply and demand back into balance, the Fed chief effectively declared victory in the battle against inflation. See full story.

But, for central bankers, the war never ends, the fronts just move.

A few months ago, Greenspan's speeches were filled with warnings about inflation, but in Tuesday's address to a meeting of the group America's Community Bankers in New York he barely mentioned the word.

Instead, he spoke about "a more sustainable supply-demand alignment," and a "softening." He said demand is "shifting down" and averred that economic growth has moderated "appreciably."

Even the labor market, with unemployment still at a 30-year low of 3.9 percent, should not be a worry for inflation hawks, he said, because increased layoffs in recent weeks "may be an early harbinger of an easing in [tight labor market] conditions."

Turning an economic one-eighty

Now, Greenspan said, the Fed's worry is that pessimism in financial markets could "signal or precipitate an excessive softening in household and business spending."

In other words, just as "irrational exuberance" in the stock market in the late 1990s threatened to spark inflation by encouraging consumers to overspend and businesses to overinvest, the bear market of 2000 now threatens to cut off spending and investment -- perhaps leading to a downturn or recession.

To be sure, Greenspan didn't articulate any fear that a recession is imminent. "Consumer confidence ... appears to be holding up reasonably well to date," he said. And businesses are still investing in productivity-enhancing technologies.

Greenspan took a typically long-term view of the carnage in the stock markets this year, especially in the Nasdaq. "To the extent that some aspiring entrepreneurs entered the tail end of a short-term boomlet, there was bound to be some disappointment," he said.

While the "current shakeup ... in the telecom and other high-tech sectors seems to reflect an inevitable winnowing process" about which firms will survive, Greenspan stuck to his theory that high technologies will increase productivity (and therefore living standards).

On watch for credit squeeze

Greenspan, speaking as he was to community bankers, warned that a credit squeeze could push the economy over the brink. Just as it has in almost every previous business cycle, bank lending "overreached" in the boom times, throwing money at people and projects that had no reasonable prospects for repayment if the economy returned to normal.

"Both bankers and their supervisors should now guard against allowing the pendulum to swing too far the other way by adopting policy stances that cut off credit to borrowers with creditable prospects," Greenspan said.

So far, he said, the credit crunch has not developed into a repeat of the credit squeeze of late 1998. And he was encouraged that risk spreads have widened for corporate borrowers and that banks have tightened up their standards without cutting off the flow of capital.

Greenspan's speech clearly signals a shift in Fed thinking, but it's not clear how the Federal Open Market Committee will translate that thinking into policy. Many Wall Street analysts are anticipating a shift in the FOMC's policy stance from tightening to neutral.

But there was little in Greenspan's speech to indicate that he sees the risks as evenly balanced between too much inflation and too little growth.

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